The accompanying notes are an integral part of the financial statements.
The accompanying notes are an integral part of the financial statements.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. NATURE OF OPERATIONS
Unless the context indicates otherwise, references to “Galaxy Gaming, Inc.,” “we,” “us,” “our,” or the “Company,” refer to Galaxy Gaming, Inc., a Nevada corporation (“Galaxy Gaming”).
We are an established global gaming company specializing in the design, development, manufacturing, marketing and acquisition of proprietary casino table games and associated technology, platforms and systems for the casino gaming industry.
Casinos use our proprietary products and services to enhance their gaming floor operations and improve their profitability, productivity and security, as well as to offer popular cutting-edge gaming entertainment content and technology to their players. We market our products and services to land-based, riverboat, cruise ship and internet gaming companies located in North America, the Caribbean, Central America, the British Isles, Europe and Africa and to cruise ships and internet gaming sites worldwide.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation.
The accompanying condensed financial statements have been prepared in accordance with
generally accepted accounting principles in the United States of America (“U.S. GAAP”)
and the rules of
the Securities and Exchange Commission (“SEC”)
. In the opinion of management, all adjustments necessary in order for the financial statements to be not misleading have been reflected herein.
As permitted by the rules and regulations of the SEC, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to those rules and regulations. The operating results for interim periods are not necessarily indicative of results that may be expected for any other interim period or for the full year.
In the opinion of management, the accompanying unaudited interim condensed financial statements contain all necessary adjustments, consisting only of those of a recurring nature, and disclosures to present fairly our financial position and the results of our operations and cash flows for the periods presented. These unaudited interim condensed financial statements should be read in conjunction with the financial statements and the related notes thereto included in our Form 10-K for the fiscal year ended December 31, 2017, filed with the SEC on April 2, 2018 (the “2017 10-K”).
Basis of accounting.
The financial statements have been prepared on the accrual basis of accounting in conformity with U.S. GAAP. Revenues are recognized when earned and expenses (
such as wages, consulting expenses, legal, regulatory and professional fees and rent)
are recognized when they are incurred. We do not have significant categories of cost of revenue, as most of our revenue is derived from the licensing of intellectual property.
Use of estimates and assumptions.
We are required to make estimates, judgments and assumptions that we believe are reasonable based on our historical experience, contract terms, observance of known trends in our company and the industry as a whole, and information available from other outside sources. Our estimates affect reported amounts for assets, liabilities, revenues, expenses and related disclosures. Actual results may differ from initial estimates.
Reclassifications.
Certain accounts and financial statement captions in the prior periods have been reclassified to conform to the current period financial statement presentations,
including the addition of restricted cash to cash and cash equivalents on the consolidated statements of cash flows as a result of the adoption of ASU No. 2016-18,
Statement of Cash Flows (Topic 230): Restricted Cash
. See below for further detail.
Other Significant Accounting Policies.
S
ee Note 3 in Item 8. “Financial Statements and Supplementary Data” included in our 2017 10-K.
Recently adopted accounting standards
Revenue Recognition.
Effective January 1, 2018, we adopted
Accounting Standards Update (“
ASU”) No. 2014-09,
Revenue from Contracts with Customers (Topic 606)
(“ASC 606”), which is a comprehensive new revenue recognition standard that supersedes virtually all existing revenue guidance, including industry-specific guidance. Under the new standard, revenue is recognized when control of the promised goods or services is transferred to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods and services. The standard creates a five-step model that generally requires companies to use more judgment and make more estimates than under the previous guidance when considering the terms of contracts along with all relevant facts and circumstances. These include the identification of customer contracts and separating performance obligations, the determination of transaction price that potentially includes an estimate of variable consideration, allocating the transaction price to each separate performance obligation, and recognizing revenue in line with the pattern of transfer. We adopted ASC 606 using the modified retrospective approach (reporting the cumulative effect as of the date of adoption).
See Note 3 for further detail.
7
Restricted Cash
.
Effective
January 1, 2018, we
adopted
ASU No. 2016-18,
Statement of Cash Flows (Topic 230): Restricted Cash
. This ASU requires amounts generally described as res
tricted cash and cash equivalents be included with cash and cash equivalents when reconciling the total beginning and ending amounts for the periods shown on the statement of cash flows.
We adopted this guidance on a retrospective basis, which resulted in
the inclusion of r
estricted cash
within cash and cash equivalents on
our balance sheets and
statements of cash flows.
Such restricted cash represents
reserves set side in a restricted bank account in accordance with the requirements of gaming regulations t
o be used for the purpose of funding payments to winners of jackpots
at one of our
client locations
and was $
6
0,996
and $95,062
at
September 30, 2018
and December 31, 2017, respectively
.
Cash flows from operating activities
for the
nine months ended
September 30, 2017
increased by $
8,693
as a result of the adoption of this guidance.
Compensation - Stock Compensation.
Effective January 1, 2018, we adopted ASU No. 2017-09,
Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting
, which provides clarification on when modification accounting should be used for changes to the terms or conditions of a share-based payment award. The adoption did not have a material impact on our financial statements.
New accounting standards not yet adopted
Leases.
In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02,
Leases (Topic 842).
The amended guidance is intended to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The guidance requires lessees and lessors to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years with earlier adoption permitted. We will adopt the new standard effective January 1, 2019 and expect to recognize a portion of our operating leases as right-of-use assets and operating lease liabilities on our balance sheets upon adoption, which will increase our total assets and liabilities.
Goodwill Impairment.
In January 2017, the FASB issued ASU No. 2017-04,
Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment,
which simplifies the current two-step goodwill impairment test by eliminating Step 2 of the test. This guidance requires a one-step impairment test in which an entity compares the fair value of a reporting unit with its carrying amount and recognizes an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, if any. This guidance is effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years, and should be applied on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. We are currently evaluating the impact of adopting this guidance and will adopt this guidance for the annual test to be performed for the year ended December 31. 2018.
Fair Value Measurement.
In August 2018, the FASB issued ASU No. 2018-13,
Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement
. ASU 2018-13 addresses the required disclosures around fair value measurement, removes certain disclosure requirements related to the fair value hierarchy, modifies existing disclosure requirements related to measurement uncertainty and adds new disclosure requirements. The new disclosure requirements include disclosing the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The standard is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods. Early adoption is permitted. We do not believe the adoption of this guidance will have a material impact on our financial statements.
Internal-Use Software.
In August 2018, the FASB issued ASU No. 2018-15,
Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract
. ASU 2018-15. This new guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The update is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods, with early adoption (including early adoption in any interim period) permitted. We do not believe the adoption of this guidance will have a material impact on our financial statements.
NOTE 3. REVENUE RECOGNITION
Adoption of ASC 606
, Revenue from Contracts with Customers
On January 1, 2018, we adopted ASC 606 and applied it to all contracts using the modified retrospective method. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts have not and will not be adjusted and continue to be reported in accordance with our historical accounting treatment under Topic 605,
Revenue Recognition
.
8
The adoption of ASC 606 had the following impact on our balance sheet and statement of
operations
: (i) we reported higher prod
uct lease
s
and royalty revenue and selling, general and administrative expense for the three
and
nine
months ended
September
30
, 2018 as a result of the assessment of our distributor relationships. We have entered into agreements with certain distributors
in Europe, which sublicense our intellectual propert
y
to gaming establishments in Europe. We have historically recorded net revenues (gross revenue generated minus distributor fees paid) as product leases and royalty revenue. However, after applying princ
ipal vs. agent considerations to these distributor relationships in accordance with ASC 606, we have determined that revenues earned from gaming establishments in Europe should now be recorded as gross revenue and fees earned by such distributors should be
recorded as selling, general and administrative expenses as we had control of the sub-licensed intellectual propert
y
prior to the licensing of such intellectual propert
y
to the gaming establishments; and (ii) p
repayments from customer
s
in advance of the p
eriod that the revenue is recognized were historically recorded under the caption “deferred revenue” in the accompanying balance sheet. This caption has now been renamed “
revenue
contract liability” in accordance with the requirements of ASC 606.
For the three months ended September 30, 2018, the adoption of ASC 606 had the following impact on our statement of
operations
:
|
|
Three Months Ended September 30, 2018
|
|
|
|
As reported
|
|
|
Balance without the adoption of ASC 606
|
|
|
Impact of the adoption
|
|
Product leases and royalties
|
|
$
|
4,775,754
|
|
|
$
|
4,544,912
|
|
|
$
|
230,842
|
|
Selling, general and administrative expense
|
|
$
|
2,559,056
|
|
|
$
|
2,328,214
|
|
|
$
|
230,842
|
|
For the six months ended September 30, 2018, the adoption of ASC 606 had the following impact on our statement of
operations
:
|
|
Nine Months Ended September 30, 2018
|
|
|
|
As reported
|
|
|
Balance without the adoption of ASC 606
|
|
|
Impact of the adoption
|
|
Product leases and royalties
|
|
$
|
13,672,459
|
|
|
$
|
12,968,848
|
|
|
$
|
703,611
|
|
Selling, general and administrative expense
|
|
$
|
7,741,213
|
|
|
$
|
7,037,602
|
|
|
$
|
703,611
|
|
Revenue Recognition
We generate revenue primarily from the licensing of our intellectual property. We also, occasionally, receive a one-time sale of certain products and/or reimbursement of our manufactured equipment.
License Fees.
We derive product lease and royalty revenue
from negotiated recurring fee license agreements and the performance of our products. We account for these agreements as month-to-month contracts for the purposes of ASC 606 and recognize revenue each month as we satisfy our performance obligations by granting access to intellectual property to our clients. In addition, revenue associated with performance-based agreements is recognized during the month that the usage of the product or intellectual property occurs.
We believe it is inappropriate to use the input method as the inputs do not correlate to the satisfaction of our performance obligations. Intellectual property requires significant upfront investment in the form of human resources required for their development and/or capital resources for acquisition from third parties. However, limited maintenance is required once the games have been placed on casino floors. The output method, on the other hand, recognizes revenue based on direct measurements of the value to our customers of the licensed intellectual property, which we believe is more appropriate. We have further applied the “as invoiced” practical expedient under the output method by recognizing product lease and royalty revenue in proportion to the amount for which we have the right to invoice.
Some of our intellectual property requires the installation of certain equipment and both the intellectual property and the related equipment are licensed in one bundled package. We have determined that the equipment is not distinct from the intellectual property and, therefore, we have only one performance obligation and, as a result, the allocation of the transaction price to different performance obligations is not necessary.
Product Sales.
Occasionally, we sell certain incidental products or receive reimbursement of our manufactured equipment after the commencement of the new license agreement. Revenue from such sales is recognized as a separate performance obligation when we ship the items.
9
Disaggregation of Revenue.
The following table disaggregates our revenue by major source for the three and six months ended September 30, 2018 and 2017:
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Table games
|
|
$
|
4,666,150
|
|
|
$
|
3,720,987
|
|
|
$
|
13,273,184
|
|
|
$
|
10,596,140
|
|
Other
|
|
|
109,634
|
|
|
|
109,433
|
|
|
|
399,466
|
|
|
|
368,384
|
|
Total revenue
|
|
$
|
4,775,784
|
|
|
$
|
3,830,420
|
|
|
$
|
13,672,650
|
|
|
$
|
10,964,524
|
|
The following table disaggregates our revenue by geographic location for the three and six months ended September 30, 2018 and 2017:
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North America and Caribbean
|
|
$
|
3,622,729
|
|
|
$
|
3,177,942
|
|
|
$
|
10,568,129
|
|
|
$
|
9,049,494
|
|
Europe
|
|
|
1,153,055
|
|
|
|
652,478
|
|
|
|
3,104,521
|
|
|
|
1,915,030
|
|
Total revenue
|
|
$
|
4,775,784
|
|
|
$
|
3,830,420
|
|
|
$
|
13,672,650
|
|
|
$
|
10,964,524
|
|
Revenue Contract Asset and Liability.
Upon the adoption of ASC 606, we have applied the
practical expedient of
expensing incremental commissions paid to sales representatives directly related to the acquisition and fulfilment of new contracts,
when the amortization period of the contract asset that we otherwise would have recognized is one year or less.
We invoice our clients monthly in advance for unlimited use of our intellectual property licenses. Upon the
adoption of ASC 606, we recognized a revenue contract liability that represents such advanced billing
to our clients for unsatisfied performance. We reduce the revenue contract liability and recognize revenue when we transfer those goods or services and, therefore, satisfy our performance obligation.
The table below summarizes changes in the revenue contract liability during the nine months ended September 30, 2018:
|
|
Revenue Contract liability
|
|
Beginning balance – January 1, 2018
|
|
$
|
1,083,639
|
|
Increase (advanced billings)
|
|
|
10,234,834
|
|
Decrease (revenue recognition)
|
|
|
(10,097,215
|
)
|
Ending balance – September 30, 2018
|
|
$
|
1,221,258
|
|
Revenue recognized during the
nine months ended September 30, 2018
that was included in the beginning balance of revenue contract liability above was $1,083,639.
NOTE 4. INVENTORY
Inventory, net consisted of the following at September 30, 2018 and December 31, 2017:
|
|
2018
|
|
|
2017
|
|
Raw materials and component parts
|
|
$
|
333,068
|
|
|
$
|
235,673
|
|
Finished goods
|
|
|
391,602
|
|
|
|
318,453
|
|
Inventory, gross
|
|
|
724,670
|
|
|
|
554,126
|
|
Less: inventory reserve
|
|
|
(30,000
|
)
|
|
|
(30,000
|
)
|
Inventory, net
|
|
$
|
694,670
|
|
|
$
|
524,126
|
|
10
NOTE 5. PROPERTY AND EQUIPMENT
Property and equipment, net consisted of the following at September 30, 2018 and December 31, 2017:
|
|
2018
|
|
|
2017
|
|
Furniture and fixtures
|
|
$
|
312,639
|
|
|
$
|
280,694
|
|
Automotive vehicles
|
|
|
215,127
|
|
|
|
215,127
|
|
Leasehold improvements
|
|
|
156,843
|
|
|
|
156,843
|
|
Computer equipment
|
|
|
157,096
|
|
|
|
121,992
|
|
Office equipment
|
|
|
53,485
|
|
|
|
53,483
|
|
Property and equipment, gross
|
|
|
895,190
|
|
|
|
828,139
|
|
Less: accumulated depreciation
|
|
|
(664,217
|
)
|
|
|
(564,272
|
)
|
Property and equipment, net
|
|
$
|
230,973
|
|
|
$
|
263,867
|
|
Property and equipment, net included $156,843 of leasehold improvements acquired under capital leases as of September 30, 2018 and December 31, 2017. Accumulated depreciation of leasehold improvements totaled $135,414 and $113,035 as of September 30, 2018 and December 31, 2017, respectively (Note 9).
For the nine months ended September 30, 2018 and 2017, depreciation expense related to property and equipment was $99,944 and $115,117, respectively.
NOTE 6. ASSETS DEPLOYED AT CLIENT LOCATIONS
Assets deployed at client locations, net
consisted of the following at September 30, 2018 and December 31, 2017:
|
|
2018
|
|
|
2017
|
|
Enhanced table systems
|
|
$
|
806,955
|
|
|
$
|
638,981
|
|
Less: accumulated depreciation
|
|
|
(431,290
|
)
|
|
|
(265,331
|
)
|
Assets deployed at client locations, net
|
|
$
|
375,665
|
|
|
$
|
373,650
|
|
For the nine months ended September 30, 2018 and 2017, depreciation expense related to a
ssets deployed at client locations was
$145,419 and $84,674, respectively.
NOTE 7. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and finite-lived intangible assets, net consisted of the following at September 30, 2018 and December 31, 2017:
|
|
2018
|
|
|
2017
|
|
Goodwill
|
|
$
|
1,091,000
|
|
|
$
|
1,091,000
|
|
Finite-lived intangible assets:
|
|
|
|
|
|
|
|
|
Patents
|
|
|
13,475,000
|
|
|
|
13,475,000
|
|
Customer relationships
|
|
|
3,400,000
|
|
|
|
3,400,000
|
|
Trademarks
|
|
|
2,880,967
|
|
|
|
2,880,967
|
|
Non-compete agreements
|
|
|
660,000
|
|
|
|
660,000
|
|
Internally-developed software
|
|
|
136,015
|
|
|
|
102,968
|
|
Other intangible assets, gross
|
|
|
20,551,982
|
|
|
|
20,518,935
|
|
Less: accumulated amortization
|
|
|
(11,284,514
|
)
|
|
|
(10,157,126
|
)
|
Other intangible assets, net
|
|
|
9,267,468
|
|
|
|
10,361,809
|
|
Goodwill and other intangible assets, net
|
|
$
|
10,358,468
|
|
|
$
|
11,452,809
|
|
For the nine months ended September 30, 2018 and 2017 amortization expense related to the finite-lived intangible assets was $1,127,389 and $1,123,980, respectively.
11
Estimated
future
amortization expense
is
as follows:
Twelve months Ending September 30,
|
|
Total
|
|
2019
|
|
$
|
1,508,864
|
|
2020
|
|
|
1,491,702
|
|
2021
|
|
|
1,401,025
|
|
2022
|
|
|
1,392,984
|
|
2023
|
|
|
253,507
|
|
Thereafter
|
|
|
3,219,386
|
|
Total amortization
|
|
$
|
9,267,468
|
|
NOTE 8. ACCRUED EXPENSES
Accrued expenses consisted of the following at September 30, 2018 and December 31, 2017:
|
|
2018
|
|
|
2017
|
|
Payroll and related
|
|
$
|
1,077,907
|
|
|
$
|
712,584
|
|
Commissions and royalties
|
|
|
77,768
|
|
|
|
65,380
|
|
Professional fees
|
|
|
19,426
|
|
|
|
63,488
|
|
Other
|
|
|
48,533
|
|
|
|
46,344
|
|
Total accrued expenses
|
|
$
|
1,223,634
|
|
|
$
|
887,796
|
|
NOTE 9. CAPITAL LEASE OBLIGATIONS
Capital lease obligations consisted of the following at September 30, 2018 and December 31, 2017:
|
|
2018
|
|
|
2017
|
|
Capital lease obligation
|
|
$
|
22,563
|
|
|
$
|
47,002
|
|
Less: Current portion
|
|
|
(22,563
|
)
|
|
|
(32,785
|
)
|
Total capital lease obligations – long-term
|
|
$
|
—
|
|
|
$
|
14,217
|
|
The capital leases consist of improvements located at our corporate headquarters in Las Vegas, Nevada.
NOTE 10. LONG-TERM DEBT
Long-term debt consisted of the following at September 30, 2018 and December 31, 2017:
|
|
2018
|
|
|
2017
|
|
Nevada State Bank Term Loan and Revolver
|
|
$
|
10,361,600
|
|
|
$
|
—
|
|
Breakaway Term Loan
|
|
|
—
|
|
|
|
9,450,000
|
|
Equipment notes payable
|
|
|
94,977
|
|
|
|
124,311
|
|
Insurance notes payable
|
|
|
—
|
|
|
|
73,734
|
|
Notes payable, gross
|
|
|
10,456,577
|
|
|
|
9,648,045
|
|
Less:
|
|
|
|
|
|
|
|
|
Unamortized debt issuance costs
|
|
|
(101,983
|
)
|
|
|
(480,397
|
)
|
Warrants issued
|
|
|
—
|
|
|
|
(584,261
|
)
|
Notes payable, net
|
|
|
10,354,594
|
|
|
|
8,583,387
|
|
Less: Current portion
|
|
|
(1,360,823
|
)
|
|
|
(1,163,002
|
)
|
Long-term debt, net
|
|
$
|
8,993,771
|
|
|
$
|
7,420,385
|
|
Nevada State Bank Credit Agreement.
On April 24, 2018, we entered into a credit agreement with
ZB, N.A.
dba Nevada State Bank (“NSB” and the “NSB Credit Agreement”), which provides for a $11.0 million five-year term loan (the “NSB Term Loan”) and a $1.0 million one-year revolving credit facility (the “NSB Revolver”).
Outstanding balances under the NSB Term Loan and the NSB Revolver accrue interest based on one-month US dollar
London interbank offered rate
(“LIBOR”) plus an Applicable Margin of 3.50%, or 4.00%, depending on our Leverage Ratio (as defined in the NSB Credit Agreement).
12
We are required to make monthly principal and interest payments, both of which are calculated over a seven-year term, with a balloon payment due on April 24, 2023. Borrowings und
er the NSB Credit Agreement are secured by a lien on substantially all of our assets.
Effective May 1, 2018, we entered into an interest rate swap agreement with an affiliate of NSB (the “Swap Agreement”) to fix the interest rate on the NSB Term Loan at 6.43% (assuming a Leverage Ratio less than 2.0) for three years. The notional amount of the Swap Agreement is initially $10.9 million but will decrease over time as a result of the anticipated principal paydowns.
The NSB Credit Agreement contains affirmative and negative financial covenants and other restrictions customary for borrowings of this nature. In particular, we are required to maintain a minimum trailing-four-quarters Fixed Charge Coverage Ratio (as defined in the NSB Credit Agreement) of 1.25 and a maximum Leverage Ratio of 3.00. The NSB Credit Agreement allows us to make share repurchases and to incur up to an additional $1.0 million of unsecured indebtedness provided that we are in compliance with the covenants in the NSB Credit Agreement on a pro forma basis. We were in compliance with the financial covenants of the NSB Credit Agreement as of September 30, 2018.
Upon execution of the NSB Credit Agreement, we borrowed $11.0 million under the NSB Term Loan and $0.1 million under the NSB Revolver. Borrowings under the NSB Revolver were repaid in full in July 2018 and $1.0 million was available at September 30, 2018 and the filing date of this Quarterly Report on Form 10-Q.
Breakaway Term loan.
In August 2016, we entered into a term loan agreement (the “Breakaway Term Loan Agreement”) for an aggregate principal amount of $10,500,000 (the "Breakaway Term Loan"). In conjunction with the Breakaway Term Loan, we also entered into a warrant agreement (the “Warrant Agreement”), pursuant to which we issued the lenders a six-year warrant to purchase 1,965,780 shares of our common stock (the “Warrants”).
The outstanding principal initially accrued interest at the rate of 14.0% per annum, which decreased to 12.5% per annum for any quarterly period in which we achieved a specified leverage ratio. Beginning October 1, 2017, the interest rate per annum decreased to 12.5% due to the achievement of such ratio.
On April 24, 2018, we used the proceeds from the NSB Term Loan and the NSB Revolver to repay in full the remaining principal amount under the Breakaway Term Loan, together with accrued but unpaid interest, an early redemption premium and associated legal fees. In addition, we redeemed the Warrants at $1,333,333. The early redemption of the Breakaway Term Loan resulted in approximately $1.3 million of loss on extinguishment of debt.
As of September 30, 2018, future maturities of our long-term debt obligations are as follows:
Twelve months Ending September
|
|
Total
|
|
2019
|
|
$
|
1,360,823
|
|
2020
|
|
|
1,437,950
|
|
2021
|
|
|
1,530,149
|
|
2022
|
|
|
1,616,655
|
|
Thereafter
|
|
|
4,511,000
|
|
Total notes payable
|
|
|
10,456,577
|
|
Less:
|
|
|
|
|
Unamortized debt issuance costs
|
|
|
(101,983
|
)
|
Notes payable, net
|
|
$
|
10,354,594
|
|
NOTE 11. COMMITMENTS AND CONTINGENCIES
Concentration of risk.
We are exposed to risks associated with a client who represent a significant portion of total revenues. For the nine months ended September 30, 2018 and 2017, respectively, we had the following client revenue concentration:
|
|
Location
|
|
2018
Revenue
|
|
|
2017
Revenue
|
|
Client A
|
|
North America
|
|
11.0%
|
|
|
13.6%
|
|
We are also exposed to risks associated with the expiration of our patents. In 2015, domestic and international patents for two of our products expired, which accounted for approximately $6,484,265 or 47.4% of our revenue for the nine months ended September 30, 2018, as compared to $5,370,094 or 49.0% of our revenue for the nine months ended September 30, 2017. We continue to generate higher revenue from these products despite the expiration of the underlying patents and, accordingly, we do not expect the expiration of these patents to have a significant adverse impact on our future financial statements.
13
Operating lease.
In February 2014, we entered into a lease (the “Spencer Lease”) for a new corporate office with an unrelated third party. The five-year Spencer Lease is for an approximately 24,000 square foot space,
which is comprised of approximately 16,000 square feet
of office space and 8,000 square feet of warehouse space.
The property is located in Las Vegas, Nevada.
The initial term of the Spencer Lease commenced on April 1, 2014 and expires on June 30, 2019. We were obligated to pay approximately $153,000 in annual base rent in the first year, and the annual base rent is scheduled to increase by approximately 4% each year. We are also obligated to pay real estate taxes and other building operating costs. Subject to certain conditions, we have certain rights under the Spencer Lease, including rights of first offer to purchase the premises if the landlord elects to sell. We also have an option to extend the term of the Spencer Lease for two consecutive terms of three years each, at the then current fair market value rental rate determined in accordance with the terms of the Spencer Lease.
In connection with the Spencer Lease, the landlord agreed to finance tenant improvements of $150,000 (“TI Allowance”). The base rent is increased by an amount sufficient to fully amortize the TI Allowance through the initial Spencer Lease term upon equal monthly payments of principal and interest, with interest imputed on the outstanding principal balance at the rate of 5.5% per annum. The TI Allowance has been classified as a capital lease on the condensed balance sheet (Note 9).
Total rent expense was $222,296 and $217,650 for the nine months ended September 30, 2018 and 2017, respectively.
Estimated future minimum operating lease payment obligations total $179,190, which are all due within the twelve months ending September 30, 2019.
Legal proceedings.
In the ordinary course of conducting our business, we are, from time to time, involved in various legal and administrative proceedings, regulatory government investigations and other matters, including those in which we are a plaintiff or defendant, that are complex in nature and have outcomes that are difficult to predict. We record accruals for such contingencies to the extent we conclude that it is probable that a liability will be incurred and the amount of the related loss can be reasonably estimated. Our assessment of each matter may change based on future unexpected events. An unexpected adverse judgment in any pending litigation could cause a material impact on our business operations, intellectual property, results of operations or financial position. Unless otherwise expressly stated, we believe costs associated with litigation will not have a material impact on our financial position or liquidity, but may be material to the results of operations in any given period. We assume no obligation to update the status of pending litigation, except as may be required by U.S. GAAP, applicable law, statue or regulation. For a complete description of the facts and circumstances surrounding material litigation to which we are a party, see Note 11 in Item 8. “Financial Statements and Supplementary Data” included in our 2017 10-K.
In September 2018, we were served with a complaint by TableMax Gaming, Inc. (“TMax”) regarding an Operation and License Agreement executed between TMax and us in February 2011 (the “TMAX Agreement”). The complaint, filed in the Eighth Judicial District Court in Clark County, Nevada, alleges that we breached the TMAX Agreement, among other allegations. We filed an answer denying the allegations and counterclaimed for breach of contract, Abuse of Process and Fraud in the Inducement, among other counterclaims. We believe the TMax complaint lacks any merit and intend to aggressively pursue dismissal of the complaint while pursuing our counterclaims.
NOTE 12. STOCKHOLDERS’ EQUITY
On March 31, 2018, we issued 13,000 restricted shares of our common stock valued at $13,520, to each of Messrs. Norm DesRosiers, Bryan Waters and William Zender, who are members of our
Board of Directors (the “
Board”),
in consideration of their service on the Board during the three months ended March 31, 2018. These shares vested immediately on the grant date.
On June 30, 2018, we issued 13,000 restricted shares of our common stock valued at $15,600, to each of Messrs. DesRosiers, Waters and Zender,
in consideration of their service on the Board during the three months ended June 30, 2018. These shares vested immediately on the grant date.
On September 30, 2018, we issued 13,000 restricted shares of our common stock valued at $16,770, to each of Messrs. DesRosiers, Waters and Zender,
in consideration of their service on the Board during the three months ended September 30, 2018. These shares vested immediately on the grant date.
On April 24, 2018, our Board authorized the repurchase of shares of our common stock in an amount not to exceed $1.0 million. Such repurchases may be made from time to time based on market conditions and may be completed in the open market or in privately-negotiated transactions. Repurchase transactions will be executed only when we believe that we will remain in compliance with the covenants of the NSB Credit Agreement. Finally, execution of share repurchases may require regulatory approval in one or more jurisdictions. We have not repurchased any of our common stock as of September 30, 2018.
14
NOTE 13. INCOME TAXES
Our forecasted annual effective tax rate at September 30, 2018 was 17.5%, as compared to 56.6% at September 30, 2017. For the nine months ended September 30, 2018 and 2017, our effective tax rate was 17.5% and 61.4%, respectively. The decrease in both rates was primarily due to a reduction in the federal statutory rate as a result of
the
Tax Cuts and Jobs Act
signed in December 2017
(the “Tax Act”)
.
As of September 30, 2018, we had completed our preliminary assessment for the tax effects resulting from the enactment of the Tax Act and made a reasonable estimate of the effect on our
annual effective tax rate and
existing deferred tax balances. We will continue to make and refine our calculations as additional analysis is completed. In addition, our estimates may also be affected as we gain a more thorough understanding of the Tax Act.
NOTE 14. STOCK WARRANTS, OPTIONS AND GRANTS
On May 10, 2018, the Board ratified and confirmed the 2014 Equity Incentive Plan (the “2014 Plan”). The 2014 Plan is a broad-based plan under which 5,550,750 shares of our common stock are authorized for issuance for awards, including stock options, stock appreciation rights, restricted stock, and cash incentive awards to
members of our Board, executive officers, employees and independent contractors
. As of
September 30, 2018
, 689,000 shares remained available for issuance as new awards under the 2014 Plan.
Stock options.
During the nine months ended September 30, 2018 and 2017, we issued 270,000 and 1,390,000 options to purchase our common stock, respectively, to members of our Board, executive officers, employees and independent contractors.
The fair value of all stock options granted for the nine months ended September 30, 2018 and 2017 was determined to be $169,807 and $652,895, respectively, using the Black-Scholes option pricing model with the following assumptions:
|
|
Nine Months Ended September 30, 2018
|
|
|
Nine Months Ended September 30, 2017
|
|
Dividend yield
|
|
|
0%
|
|
|
|
0%
|
|
Expected volatility
|
|
78%
|
|
|
80 - 87%
|
|
Risk free interest rate
|
|
2.46% - 2.73%
|
|
|
1.73 - 1.94%
|
|
Expected life (years)
|
|
|
5.00
|
|
|
|
5.00
|
|
A summary of stock option activity is as follows:
|
|
Common
stock options
|
|
|
Weighted-
average
exercise price
|
|
|
Aggregate
intrinsic
value
|
|
|
Weighted-average
remaining contractual
term (years)
|
|
Outstanding – December 31, 2017
|
|
|
2,811,250
|
|
|
$
|
0.54
|
|
|
$
|
1,849,517
|
|
|
|
3.65
|
|
Issued
|
|
|
270,000
|
|
|
|
0.98
|
|
|
|
—
|
|
|
|
—
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Expired
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Outstanding – September 30, 2018
|
|
|
3,081,250
|
|
|
$
|
0.58
|
|
|
$
|
2,186,179
|
|
|
|
3.05
|
|
Exercisable – September 30, 2018
|
|
|
2,317,916
|
|
|
$
|
0.52
|
|
|
$
|
1,775,996
|
|
|
|
2.78
|
|
A summary of unvested stock option activity is as follows:
|
|
Common stock
options
|
|
|
Weighted-average
exercise price
|
|
|
Aggregate
intrinsic
value
|
|
|
Weighted-average
remaining contractual
term (years)
|
|
Unvested – December 31, 2017
|
|
|
825,557
|
|
|
$
|
0.63
|
|
|
$
|
467,379
|
|
|
|
4.27
|
|
Granted
|
|
|
270,000
|
|
|
|
0.98
|
|
|
|
—
|
|
|
|
—
|
|
Vested
|
|
|
(332,223
|
)
|
|
|
0.64
|
|
|
|
—
|
|
|
|
—
|
|
Forfeited or expired
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Unvested – September 30, 2018
|
|
|
763,334
|
|
|
$
|
0.75
|
|
|
$
|
410,184
|
|
|
|
3.82
|
|
As of September 30, 2018, our unrecognized stock-based compensation expense associated with the stock options issued was $299,788, which will be amortized over a weighted-average of 1.81 years.
15
Warrants.
On August 29, 2016, in connection with the
Breakaway
Term Loan Agreement, we issued the
lenders the
Warrants to purchase
1,965,780 shares of our common stock at an initial exercise price of $0.30 per share
.
On April 24, 2018, we
paid $1,333,333 to redeem the Warrants in full upon extinguishment of the Breakaway Term Loan (Note 1
0
).
NOTE 15. FAIR VALUE OF FINANCIAL INSTRUMENTS
We estimate fair value for financial assets and liabilities in accordance with Accounting Standards Codification (“ASC”) Topic 820,
Fair Value Measurement
(“ASC 820”). ASC 820 defines fair value, provides guidance for measuring fair value, requires certain disclosures and discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow) and the cost approach (cost to replace the service capacity of an asset or replacement cost). ASC 820 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels:
|
•
|
Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.
|
|
•
|
Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.
|
|
•
|
Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.
|
The estimated fair value of cash equivalents, restricted cash, accounts receivable and accounts payable approximates their carrying amount due to their short-term nature. The estimated fair value of our long-term debt and capital lease obligations approximates their carrying value based upon our expected borrowing rate for debt with similar remaining maturities and comparable risk. As of
September 30, 2018
,
the interest rate swap agreement was
the only financial instrument measured at estimated fair value on a recurring basis based on
valuation reports provided by counterparties, which are classified as
level 2 inputs.
NOTE 16. SUBSEQUENT EVENTS
On October 12, 2018, we granted the following stock options to purchase our restricted common stock: (i) 250,000 to Todd Cravens, our President and Chief Executive Officer; (ii) 180,000 to Harry Hagerty, our Chief Financial Officer; and (iii) 45,000 to our general counsel. The stock options were issued with a strike price of $1.187, have a contractual term of five years, contain customary change-of-control provisions, and vest in equal installments on each of the first three anniversaries from the grant date.
On November 5, 2018, we issued a press release and filed a related Form 8-K announcing that (i) Robert B. Saucier submitted his resignation as a member of our Board effective immediately and his resignation as Executive Vice President of Business Development effective on December 31, 2018; and (ii) that we have retained Macquarie Capital (USA) Inc.
to assist it in evaluating strategic alternatives, including the potential sale of the shares of our common stock held by Triangulum Partners LLC, an entity controlled by Mr. Saucier.
16